Amazon Plays Hardball with Electronics Distributors

Since launching in April 2015, Amazon’s new business-to-business (B2B) marketplace has been doing some tidy business. Inside a year, Amazon Business has topped $1 billion in sales and hit a month-over-month growth rate of 20%. 

Amazon’s progress should be worrisome for electronics distributors everywhere.

By empowering third-party sellers to reach new markets at virtually zero marginal cost, Amazon Business is growing rapidly and could easily lead the market by the end of the decade.

As the unit grows, Amazon Business is casting a wide net for B2B product listings, rather than concentrating on a single vertical, which means electronics and electronic components are already on its radar.

In tandem with Amazon’s growth comes a wave of change in demand for B2B distribution at large. Customers increasingly want more price transparency and easier purchasing options, both of which Amazon excels at and which most established distributors have built their success on avoiding.

Many verticals within B2B distribution feature not only a lack of transparency, but a high degree of fragmentation and commoditization. Electrical, industrial, MRO, chemical, building materials, and metal distribution are all fragmented markets where many product offerings are standardized. 

In other words, these industries are incredibly vulnerable to disruption. 

Doomed to disruption

Since these more commoditized products can be produced and sold by virtually anyone, Amazon can leverage its considerable resources and have little trouble sourcing suppliers from these verticals of similar quality to what’s currently offered by established distributors. In several of these verticals, it already has begun.

As Amazon hones in on these markets, there’s little these large distributors can do to resist the change because none of them hold enough market share to choke off marketplace disruption. 

In its current state, electronics distribution is led by a small group of companies: only the top ten collect more than $1 billion in annual revenue, led by Avnet and Arrow. Looking further down the rankings, the reported annual revenue steadily and steeply declines, with the 24th and 25th largest distributors not even approaching $100 million, pulling in less than 1% of either Avnet or Arrow. 

The reason for this top-heavy concentration is that these leading firms fill orders for heavily customized products, often at levels that can’t be replicated, which prevents commoditization. In these less commoditized product areas, Arrow and Avnet have built themselves a defensive moat against their competitors, including Amazon.

However, these distributors don’t only sell custom electronic products. They also sell passive products, such as capacitors and transformers, and maintenance/repair/operations (MRO) and computing products, which are more standardized.

Much like what happened with Circuit City and other consumer electronics retailers, Amazon doesn’t have to sell the large, complicated items for it to affect a distributor’s business. It can start with smaller or more commoditized items, placing significant price pressure on distributors in these areas and eating into their margins.

In Circuit City’s case, it ignored this competitive threat for years, even letting Amazon run most of its e-commerce on the Amazon Marketplace. Just three years after reaching its peak revenue and stock price in 2006, a broken Circuit City filed for bankruptcy.

The same fate could befall a company like Arrow. While its downfall won’t likely be as severely as Circuit City’s, 19% of Arrow’s 2016 revenue did come from passive products, while another 14% came from more commoditized product segments like MRO and computing and memory. In an industry with very tight margins, a large distributor like Arrow can’t afford to lose a significant portion of its revenue. Its cost structure won’t support it.

So how does that happen?

Amazon plays hardball

If Amazon wants to stay local, it only needs to convince a handful of suppliers to join its marketplace. Arrow’s suppliers aren’t as numerous as for more commoditized verticals, but that means less legwork for Amazon’s seller acquisition folks.

Should American electronics makers choose not to list on Amazon, there’s still a substantial number of factories located just across the Pacific. Many Chinese manufacturers would jump at the chance to increase North American sales, especially if the border adjustment tax proposal doesn’t come to fruition.

And Amazon would be happy to have them. They’d cost less than their American counterparts and likely draw a lot of price-sensitive customers, so long as product quality is controlled. With Amazon’s steadily improving logistics game , that trans-Pacific journey won’t be as daunting as many would expect. 

The losses Arrow could face if it doesn’t respond to the Amazon threat are significant.

That’s gonna leave a mark

In a downside model that assumes it’ll follow a similar path to Grainger, which recently announced the rollout of an across the board 15 to 25% list price cut on its more commoditized products, Arrow will need to decrease the price of its more commoditized products by 15% over three years to compete with Amazon.

This pricing pressure would essentially cut the company’s operating income in half within three years, which is the likely timeframe Amazon needs to scale up its sales in these product segments to dominate.

To be clear, this is a rough projection with assumptions, but it’s still the kinder version of the analysis. In the worst case, requiring a more aggressive price cut, Arrow’s operating income could drop to a $400 million annual loss in the same three year period.

The model assumes a consistent level for operating expenses (which have grown slightly over the last several years) and a generous 4% annual growth rate in the company’s other services.

For, smaller distributors like Sager or Masters, Amazon’s B2B marketplace could present an opportunity. Many companies in other industries have built their businesses on being early adopters of marketplaces like Amazon or Alibaba. These smaller distributors will have a chance to expand their access to consumers at very low marginal costs.

Image courtesy: Sager

Image courtesy: Sager

The larger distributors won’t have the same luxury. Their shareholders won’t enjoy losing margins to Amazon in the same market their companies already dominated. 

When Amazon moves on the electronics market, established distributors need to have battle plans in deployment already. 

As the e-commerce giant further masters the B2B space, it’ll scale up new verticals with increasing ease. Companies like Arrow, Avnet, and Future should be examining the marketplace model for the commoditized segments of their market now before it’s too late. 

Not only will it offer a bulwark against an intrusion from Amazon, but it’ll proffer a new business unit that will scale well and offer significant opportunity for growth. If one of these companies successfully pursues digital transformation, builds a marketplace, it could very well find itself becoming the modern monopoly for electronics distribution.

2 comments on “Amazon Plays Hardball with Electronics Distributors

  1. prooks
    April 22, 2017

    Though i agree with your comments that there is severe risk for Arrow, Avnet and Future's commodity business, customers who end up using Amazon for purchasing are taking significant risk when procuring non-authorized product.  Counterfeit product is rampant in the electronics industry and trying to save money by using a non-franchised methodology can be penny wise and pound foolish.  Components that cost from a nickel to a couple of hundred dollars that end up not working on a board or system can cause thousands of dollars of cost to a manufacturer, not to mention the cost of perceived quality.  Further, even though there are literally tens to hundreds of low cost suppliers trying to supplant established semiconductor companies, quality of product will always play a significant role in a decision to use a supplier.  It's easy to generalize that low cost solutions will envelope an industry and technology if there isn't value add, but in an industry where technological deficiency will destroy an end customer, there is no room for acceptable low cost/quality offerings.

  2. juancampos
    May 15, 2017

    Very interesting discussion here. While I do agree that this could lead to the downfall of major players in the electronics industry, as a business owner in both the logistics and construction industries, I've seen how the opposite could also be true as well, especially with ever-changing demographics. I suppose only time will tell… 

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